With the passage of the Tax Cuts and Jobs Act of 2017 just before the end of 2017, Congress and the President radically altered the financial landscape for spouses contemplating a divorce, and some of the changes will be challenging to plan around.
The biggest, most noticeable difference involves maintenance (sometimes called alimony). Under the previous tax code, a spouse paying maintenance could deduct all of those payments, lowering that spouse’s pre-tax income. Note that most spouses receiving maintenance are women, and usually they receive maintenance because they have been caregivers raising children and not active in the workplace. While they will have a duty to pursue employment, they will have limited employment capacity for some time, and therefore require maintenance to both make ends meet and continue the lifestyle established during the marriage. But during the marriage, one income covered a couple living in one household; now, after divorce, one income has to help cover two people living in two separate households. The income has not changed but the expenses have nearly doubled. For years, the tax code has helped divorced families with the maintenance deduction, expanding family income by giving back to the family between 25% and 40% of the total maintenance paid. For a spouse paying $50,000 in maintenance, for example, that expanded the family income by between $12,500 and $20,000 a year. In effect, it made maintenance affordable and it made supporting two households on one income possible. It also gave spouses more flexibility in arranging property and support settlements.
Under the new tax law, effective January 1, 2019, maintenance will no longer be deductible, meaning that in our example of the saving spouse, that spouse now loses the $12,500 to $20,000 annually – a loss born by the whole family. It puts financial pressure on the whole family and will likely make the amount of spousal support awards smaller, hurting families overall.
Another less talked about change involves the dependency exemption. Under the old tax code, a parent able to claim a child as a dependent could claim $4,050 per child. Usually this would benefit the spouse receiving maintenance because that spouse probably has the child more than 50% of the year. Because the spouse must pay tax on the maintenance received, the dependency exemptions usually helped limit that spouse’s overall tax burden to a de minimus amount.
Under the new tax law, the dependency exemption is suspended until 2026, replaced by a larger exemption for individuals and heads of household – however, this new exemption is less than it would have been for spouses with multiple children under the old law. Again, the effect of the new law is to reduce the overall family income and put burdens on the lower earning spouse.
One possible positive change in the new law involves the increased child tax credit. The threshold to qualify has been raised to $200,000 for a single person, and is designed to refund in taxes amounts parents pay for childcare. This benefit could certainly help divorced spouses who can claim the tax credit, and will at least partially compensate for the loss in tax benefits elsewhere.
The singular takeaway from the changes in the tax code for divorcing spouses – know what the law will do to you and plan accordingly. If maintenance looks like a poor option, consider other settlement arrangements that might qualify for tax benefits to the paying spouse (they do exist, but require consulting a financial advisor or accountant). But importantly, do not make a settlement without understanding the tax implications, or else both spouses could find the settlement failing to meet expectations and not financially feasible – after the fact.
If you have questions about the new tax law and divorce, contact us – we can help.